Introduction
The trade-off between risk and return is an always been a concerned for the analysts and researchers and the concepts related to the same are extremely effective and essential. Financial Management is one of the largest fields which have different dominating options embedded in it. Financial Management is a combination of two things that are managing and finance. It means that the management of the financial function is more than essential and effective for the sake of the organization (Elton, Gruber, Brown & Goetzmann, n.d.).
The concept of risk and return has number of aspects as well in which different techniques and tools would have been applied and used. Management of finance is actually the management of a portfolio, which is an effective tool to mitigate the risk accordingly. As per the investment gurus, portfolio is an interchangeable name of diversification that is the most widely used terms in the entire investment management function. The basic intelligence of an analyst or a researcher lies in the aspect to diversify their portfolio and function in a manner that no two securities would have been embedded in the same picture at the same time. Therefore, proper allocation of the funds is more than necessary for an investor to perform exquisitely in the way of risk and return (Fabozzi & Fabozzi, 2007).
It is required to make the portfolio by having four different aspects which are US Equity, Australian Equity, Long Term Bond and Cash. There are certain aspects that needed to be control accordingly and effectively. Questionnaire should have been made in this particular assignment in order to get the risk profile of the investor. According to the scenario, the client is willing to invest $ 10 million for the next 10 years. The client is strategizing to have a total of $ 15 million equity at the end of the maturity to buy a large Vineyard in Southern Australia.
Analysis and Findings
There are certain sub-sets addressed in this assignment, and each of the categories would be defined, analyzed and then addressed accordingly and simultaneously
Questionnaire
There are three questions that required to be used in this particular questionnaire to analyze the risk profile of the investors
Which Statement has described the degree of loses you are willing to take? (OPTION-2)
- Minimal Amount of loss
- Moderate loss
- High Capital Loss
Are you willing to have a stop loss on your equity? (YES)
Yes
No
What type of investor are your? (MODERATE)
Aggressive
Moderate
Slow
Questionnaire Affects
The questionnaire affects a lot with the risk and effect of the portfolio allocation accordingly. The questionnaire will analyze the risk profile of the individual of the client. On the basis of risk profile, the information regarding the proper allocation would have been analyzed and effective actions could have been taken.
The Selection of US-Equity and its Rationale
Equity is one of the most important aspects associated with an organization as it gives an opportunity to an organization in terms of increasing their investment accordingly (Fabozzi & Fabozzi, 2007). Equity, usually represents the amount of money that has been invested by the external investors in the stocks and securities of the company, and they are essential for their effectiveness.
The equity of the United States (US) is some of the major parts of their effectiveness and fragility and there are certain aspects that deem essential for the investors as far as investing in the US equity is concerned. The United States is the largest economy of the world in which the financial and capital share markets are quite big and momentous (Leahigh & Reilly, 2000). The market of the US has sufficient securities in it which are effective and essential and termed as the heaven of investment for the investors. The main rationale behind the selecting the US equity as an investment opportunity for the investor is its tremendous growth from the last decade. US equity and securities are not in the mood to have influence of the major players in the market unlikely the other share markets in which big players of the market can deliberately change the prices and return of the shares of the company. The Index of the United States (US) has been taken into consideration to have a mean return, standard deviation and other important information of the market. It is also required to analyze the required return with the help of Dividend Discount Model (DDM).
Mean Return/Standard Deviation Analysis
Mean Return of the US Equity is 0.009697%, while the mean standard deviation of the observations is 0.0453%, showing that the proportion of return and risk is very low. Standard deviation analyzes the level of risk in a security and a security with high standard deviation should not be selected by the company.
Variance and Co-Variance Analysis
Variance is the square of standard deviation or risk (Ranganatham & Madhumathi, 2006). The mean variance of the US equity is 0.00265%, which is again quite low and effective and it will be effective of the investors to get the same amount of variance in order mitigate and manage the risk accordingly. Co-variance is the name of a statistical measure analyzes the risk relationship among two securities. The Co-Variance of US-Equity with Australian Equity, Fixed Income and Cash Securities are 0.001389%, 0.000184 and 0.00000679 respectively, which is quite low and showing that the level of combined riskiness among these securities are quite low that deem favorable for the investor.
Correlation Analysis
Likewise Co-variance, Correlation is yet another important concept stick with the field of statistics and finance that analyzes the core relationship among the return and risk of two or more than two securities. The level of correlation among US Equity and all other securities are positive. The correlation among US Equity with Australian Equity, Fixed Income and Cash are 0.57%, 0.16% and 0.14% respectively that are positive and moderate. It means the return and risk of all of these securities are adjacent to each other.
Dividend Discount Modeling
Dividend Discount Model is an important valuation model of the actual price of a security. The formula is mentioned below
P = D / KE – G
KE = For the Cost of Equity, CAPM model has been used
CAPM = RRF + Beta (RM – RRF)
Beta = 1.2
RRF = 4.5%
RM = 10%
CAPM = 4.5% + 1.2 (10 – 4.5)
KE = 11.1%
P = 34.09 / 11.1% - 1.925%
= 34.09 / 9.175%
P = 371.55
The current price is 6,218 $, but it has actual worth of $ 371.55. Short Selling is recommended
The Selection of Australian Equity and its Rationale
Australian Equity is also an important type of equity which is effective for the investment purpose. Likewise US Equity, the effectiveness of Australian Equity is also effective (Ranganatham & Madhumathi, 2006). Australia is the 6th largest economy of the world and people belong to different countries of the world have invested in the stocks of the Australia to have effectiveness. There are a number of companies of the world that are having their existence in the Australian share market, and different equities are trading in the market. The securities in this particular market are booming from last few years, and it is an effective sign for the investors wishing to invest in the securities of the country.
Mean Return and Standard Deviation
Mean return and standard deviation are some of the important statistical based concept that analyzes the stance of the company in managing the return of the company. The mean return of Australian Equity is 0.01038% that is quite low, and the standard deviation is 0.053% which is again quite low. It is showing that the proportion of mean and standard deviation is quite low showing that the risk association with the company is quite low (Ranganatham & Madhumathi, 2006).
Variance and Co-Variance Analysis
Likewise mean and standard deviation is also an effective tool which used to analyze the effectiveness of the securities that is Variance and Co-variance analysis. The variance of the Australian Security is 0.00287% which is quite low as likely by the US Equity. The Co-Variance among the Australian Equity and US Long Term Growth is negative, and it is -0.00000528 while the co-variance among Australian Equity and Cash is -0.00000363%. This particular analysis is showing that the level of variance and co-variance among different elements and securities is quite low.
Correlation Analysis
An analysis of the relationship among different securities is known as Correlation analysis (Ranganatham & Madhumathi, 2006). Correlation among the Australian Equity and US Long term Fixed Income is negative and it is -0.0397%, showing that the relationship among both of these securities are negative and both of these securities goes in different directions with each other. The relationship among the Australian Equity and cash is also negative which is -0.000000617%
Dividend Discount Modeling
The formula is mentioned below
P = D / KE – G
KE = For the Cost of Equity, CAPM model has been used
CAPM = RRF + Beta (RM – RRF)
Beta = 1.4
RRF = 4.5%
RM = 11.5%
CAPM = 4.5% + 1.4 (11.5 – 4.5)
KE = 14.3%
P = 76.87 / 14.3% - 0.925%
= 76.87 / 13.375%
P = 574.72
The current price is 1,834 $, but it has actual worth of $ 574.22. Short Selling is recommended
The Selection of US Fixed Income and its Rationale
Fixed Income is an important aspect from the viewpoint of investment. With the help of this particular security, the fixed income securities and investment would be effective and essential (Ranganatham & Madhumathi, 2006). Most of the investors of the world are now focusing on a fixed income as it has a tendency to give a certain amount of money to the investor in a given time frame. The rationale of selecting the fixed income is quite essential for the investors as it has the lowest amount of risk association because most of the times, the fixed income would be government backed. Some of the major types of fixed income securities found in the United States (US) are Treasury Bills, Securities and Notes, which are effective for the investors.
Mean and Standard Deviation Analysis
The mean and standard deviation of US fixed income is 0.00422% and 0.0248% respectively. It is quite low as compared to other securities in particular. It is required that both of these aspects should be increased considerably (Reilly & Brown, 1997).
Variance and Co-variance Analysis
The computed variance and co-variance of the company is 0.000618% and 0.0002468% respectively. This particular computation is showing that the securities are less risky in particular that is an effective sign for the investor again.
Correlation Analysis
The correlation of US Fixed Income and Cash is 0.90 which is positive and extremely high, showing that it will be effective to invest accordingly in particular. The relationship is effective that shows that both of these investment vehicles are moving related to each other.
Dividend Discount Modeling
The formula is mentioned below
P = D / KE – G
KE = For the Cost of Equity, CAPM model has been used
CAPM = RRF + Beta (RM – RRF)
Beta = 1.1
RRF = 4.5%
RM = 12.4%
CAPM = 4.5% + 1.1 (12.4 – 4.5)
KE = 13.9%
P = 60.12 / 13.9% - 0.01%
= 60.12 / 13.89%
P = 435.65
The current price is 600 $, but it has actual worth of $ 435.65. Short Selling is recommended
Cash Securities Selection and its Rationale
Cash Securities and its accumulation are effective from the viewpoint of investment, and the importance of cash securities would be essential in particular. If the levels of cash securities are on a higher scale, then it provides effectiveness to the investors particularly (Reilly & Brown, 1997).
Mean and Standard Deviation Analysis
The mean and standard deviation of US fixed income is 0.00392% and 0.01101% respectively. It is quite low as compared to other securities in particular. It is required that both of these aspects should be increased considerably.
Variance and Co-variance Analysis
The computed variance and co-variance of the company is 0.000121% and 0.0002465% respectively. This particular computation is showing that the securities are less risky in particular which is an effective sign for the investor again (Reilly & Brown, 1997).
Correlation Analysis
The correlation of US Fixed Income and Cash is 0.90 which is positive and extremely high, showing that it will be effective to invest accordingly in particular. The relationship is effective that shows that both of these investment vehicles are moving related to each other.
Dividend Discount Modeling
The formula is mentioned below
P = D / KE – G
KE = For the Cost of Equity, CAPM model has been used
CAPM = RRF + Beta (RM – RRF)
Beta = 1.2
RRF = 4.5%
RM = 11.4%
CAPM = 4.5% + 1.2 (11.4 – 4.5)
KE = 12.78%
P = 56.78 / 12.78% - 0.01%
= 56.78 / 12.77%
P = 444.63
The current price is 526 $, but it has actual worth of $ 444.63. Short Selling is recommended
Portfolio Management Analysis
According to the crux of the assignment, there is a client found in it that has 10 million $ to invest in different investment vehicles. The client is willing to invest this huge amount of money for the next 10 years in order to make effective leadership and profit (Swensen, 2000). Management of Portfolio not only increased the amount of profit for the investment, but it also uses to mitigate the level of riskiness from a security or from the portfolio used for the investment purpose. Investment in a portfolio, usually allocated different amount of proportion to the different investment vehicles, related to the effectiveness of the mean return and association standard deviation of the medium. The allocation has been analyzed by considering the risk profile of the individual. The allocation of investment is mentioned below
Highest proportion of allocation has been allocated with Australian-Equity because it has the highest amount of mean return proportion with it, while 30% have been allocated with US-Equity. Fixed Income and Cash have a net proportion of 20% and 10% respectively.
Portfolio return is 0.83% which is higher than that of individual securities, which is showing that making of the portfolio certainly increases the rate of return accordingly and effectively, while the associated risk is 0.041% which lies in an effective region in particular. The client who has been found in this analysis looks a moderate risk taker and the riskiness associated with the securities are also quite low which is an effective sign from the viewpoint of portfolio management. The main theme of this part is to analyze that how much dollar return will be having after a period of 10 years.
= 10,000,000 * 0.83%
= $ 83,000 in 1 year
= 83,000 * 10 = $ 830,000
Total Equity would become
10,000,000 + 830,000
= $ 10,830,000
The amount of return is higher which is 830,000 $ per 10 years, and it is found that the effectiveness of the investment would be on a higher scale in particular. However, the amount that the client was expecting to have was $ 15 million which has not been achieved and the client cannot buy a large vineyard in the Southern Australian region in particular. It is not an effective sign for the investor, and they have to find some new investment vehicles to become more effective in their investment.
Conclusion
Investment is an important and integral activity from the viewpoint of an investor, and it has certain aspects that needed to be analyzed accordingly. Risk and Return trade-off are significant and important for the investors and investors have to analyze and considers the things accordingly. There are certain investment vehicles which are essential for the investment purpose and these investment vehicles can increase the level of portfolio accordingly. The main purpose of every investment is to increase the level and amount of equity in particular. There are number of tools and techniques that could be used for the same purpose, including mean return, standard deviation, variance, co-variance and others. Usually, it applies in almost every investment and investment purposes, and it is applied in this particular investment technique as well. The scenario is long for this assignment, and there are certain aspects that needed to overcome accordingly in the assignment. There is a client who has 10 million $ in their hands, and they want to invest it in different investment vehicle. There were a four different investment vehicles which have been taken into account for the assignment, which are US Equity, Australian Equity, Fixed Income and Cash. From the analysis, it is found that the investment would be effective as far as increasing the return and mitigating the risk accordingly and effectively and it will be a perfect sign for the client, but the client cannot buy the vineyard in Southern Australia.
References
Elton, E., Gruber, M., Brown, S., & Goetzmann, W. Modern portfolio theory and investment analysis (1st ed.).
Fabozzi, F., & Fabozzi, F. (2007). Fixed income analysis workbook (1st ed.). Hoboken, N.J.: J. Wiley.
Leahigh, D., & Reilly, F. (2000). Student self-study problems manual to accompany Investment analysis and portfolio management, sixth edition, Frank K. Reilly, Keith C. Brown (1st ed.). Fort Worth, Tex.: Dryden Press.
Ranganatham, M., & Madhumathi, R. (2006). Investment analysis and portfolio management (1st ed.). Delhi, India: Pearson Education/Dorling Kindersley (India).
Reilly, F., & Brown, K. (1997). Investment analysis and portfolio management (1st ed.). Fort Worth, Tex.: Dryden Press.
Swensen, D. (2000). Pioneering portfolio management (1st ed.). New York: Free Press.
